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  • Writer's pictureLisa Perry

Understanding Investment Risk

Updated: May 2, 2023

Inflation Risk

Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant if you own cash or debt investments like bonds. Shares offer some protection against inflation because most companies can increase the prices they charge to their customers. Share prices should therefore rise in line with inflation. Real estate also offers some protection because landlords can increase rents over time.

Interest Rate Risk

Applies to debt investments such as bonds. It is the risk of losing money because of a change in the interest rate. For example, if the interest rate goes up, the market value of bonds will drop.

Currency Risk

Applies when you own foreign investments. It is the risk of losing money because of a movement in the exchange rate. For example, if the South African Rand becomes less valuable relative to the US dollar, your South African Rand will be worth less in US dollars.

Regulatory Risk

Is the risk of a change in regulations and law that might affect an industry or a business. Such changes in regulations can make significant changes in the framework of an industry, changes in cost-structure, etc. An example would be the mining charter in South Africa.

Liquidity Risk

Is the risk of being unable to sell your investment at a fair price and get your money out when you want to. To sell the investment, you may need to accept a lower price. In some cases, it may not be possible to sell the investment at all.

Concentration Risk

Is the risk of loss because your money is concentrated in 1 investment or type of investment. When you diversify your investments, you spread the risk over different types of investments, investment managers, industries or market sectors and geographic locations.

Reinvestment Risk

Is the risk of loss from reinvesting principal or income at a lower interest rate. Suppose you buy a bond paying 5%. Reinvestment risk will affect you if interest rates drop and you have to reinvest the regular interest payments at 4%. Reinvestment risk will also apply if the bond matures and you have to reinvest the principal at less than 5%. Reinvestment risk will not apply if you intend to spend the regular interest payments or the principal at maturity.

Credit Risk

Is the risk that the government entity or company that issued the bond will run into financial difficulties and won’t be able to pay the interest or repay the principal at maturity. Credit risk applies to debt investments such as bonds. You can evaluate credit risk by looking at the credit rating of the bond. For example, long-term Canadian government bonds have a credit rating of AAA, which indicates the lowest possible credit risk.

Market Risk

Applies to an investment in shares. The market price of shares varies all the time depending on demand and supply. Equity or market risk is the risk of loss because of a drop in the market price of shares.

Political Risk

A type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business sector or the expected value of a given economic action. The term political risk has had many different meanings over time.

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